Nonprofit Organization Urges Caution if IRS Regulates Charitable Trusts

A key nonprofit association that promotes philanthropy has advice for the Internal Revenue Service on how the government could crack down on a questionable giving arrangement without thwarting well-meaning donors and charities.

The association — the American Council on Gift Annuities — said it wants to be sure that any corrective regulation or legislation is fair to contributors and organizations coping with the bad economy.

Last fall, the IRS and the Treasury Department said in Notice 2008-99 that they were concerned that some charitable remainder trusts had been created and closed early, apparently to allow donors to avoid paying capital-gains taxes.

The government said the transaction “has the potential for tax avoidance or evasion” and asked for public comments on the matter by January 31.

A charitable remainder trust enables a donor to designate a gift to a charity, take a tax deduction for the donation, and receive regular income payments from the gift (or designate someone else to receive them).

After a set period of years, or upon the death of the donor (or other beneficiary of the trust), the trust assets go to the charity.

Donors often use an appreciated asset, such as stock, to create the trusts and pay taxes on all or most of the payments they receive from the trusts.

In their public notice, the IRS and the Treasury Department gave an example of the kind of transaction that is causing alarm.

A donor creates a charitable remainder trust and contributes highly appreciated assets. If the donor had sold those assets, he normally would have had to pay capital-gains taxes. He designates a charity as the “remainder beneficiary.”

The trust then sells the donated assets and reinvests the proceeds in marketable securities or other new assets.

The donor and nonprofit organization then sell their entire interest in the trust to an unrelated third party for an amount of money that approximates the fair market value of the trust’s assets. The donor and charity then close the trust.

The donor receives his interest in the trust’s assets and maintains he does not owe capital-gains taxes.

Donor Gains

In the donor’s view, the sale of trust assets by the trust during its term and the purchase of replacement assets give the new assets — for determining any capital gain — a new value equal to the purchase price (instead of the cost of the original assets).

In the end, the government would not be paid any taxes on the sale of the appreciated assets even though the donor has reaped a big gain on assets that have grown in value since the original purchase.

The IRS and the Treasury Department said donors and charities entering into those kinds of transactions on or after November 2, 2006, must notify the government.

The American Council on Gift Annuities, in comments filed with the IRS and the Treasury Department, said it supported the government’s efforts to curb any abuse.

But the comments — prepared by Conrad Teitell, a Connecticut lawyer and planned-giving expert — said that “any corrective regulation or legislation should deal fairly with and not thwart proper transactions.”

In this bad economy, the American Council on Gift Annuities said, some donors and charities are closing charitable remainder trusts early because “the charities need funds now (instead of in the future when the trust term ends) and the [donors] need immediate funds (instead of piecemeal over the balance of the trust term).”

For these contributors and organizations, “improper capital gain avoidance is not on their radar,” the council said.

The American Council on Gift Annuities proposed that the government deal with abuse by reducing the donor’s “stepped-up basis” — the price paid by the trust for assets it bought before the trust was closed — by any capital gains sitting in the trust that haven’t been distributed to the donor in satisfaction of his income payments.

The council said this solution is fair to the government, donors, and charities.

To read the council’s comments and its detailed suggestions for what the federal government should do about the issues raised in Notice 2008-99, go to its Web site.